WEINER v. QUAKER OATS CO.

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY

May 23, 1996

MYRON WEINER, NICHOLAS SITNYCKY, RONALD ANDERSON, and ROBERT FURMAN, on behalf of themselves and all others similarly situated, Plaintiffs,
v.
THE QUAKER OATS COMPANY and WILLIAM D. SMITHBURG, Defendants.

Weiner, Sitnycky, Anderson and Furman allege they represent a class of people who purchased Quaker common stock during the period 4 August 1994 through and including 1 November 1994 (the "Class Period").
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Second Amended Complaint, PP 4, 12. On 22 September 1994, Weiner purchased 300 shares of Quaker common stock at a price of $ 80 3/8 per share and 700 shares at a price of $ 80 7/8 per share. Id., P 7(a). On 23 September 1994, Sitnycky purchased 500 shares of Quaker common stock at a price of $ 78 3/4 per share and on 27 September 1994, purchased an additional 2000 shares at a price of $ 80 1/4 per share. Id., P 7(b). On 29 September 1994, Anderson purchased 200 shares of Quaker common stock at a price of $ 78 1/8 per share. Id., P 7(c). On 12 October 1994, Furman purchased 1000 shares of Quaker common stock at a price of $ 77 1/8 per share. Id., P 7(d).

Quaker has used borrowed capital, termed leverage, to finance its growth in the recent past. Id., P 21. Plaintiffs allege higher leverage increases the risk to equity investors, whose interests are subordinated to those of debt holders. Id. In its Annual Report to Shareholders for the fiscal year ending 30 June 1993 (the "1993 Annual Report"), Quaker made the following statement concerning leverage:

Smithburg reiterated this total debt-to-total capitalization ratio guideline (the "Leverage Ratio Guideline") in the 1993 Annual Report's Letter to Shareholders, in which he stated:

Our Board of Directors [has] authorized an increase in our leverage guideline, along with a share repurchase program of up to 5 million shares. Our guideline for leverage in the future will be to maintain a total debt-to-total capitalization ratio in the upper-60 percent range.

1993 Annual Report at 35 (emphasis added) (attached as Exh. B to Block Aff.); Second Amended Complaint, P 23. Quaker included a similarly worded statement in its Form 10-Q for the quarter ending 30 September 1993 ("September 1993 10-Q"), filed with the SEC in November 1993. September 1993 10-Q at 9 (attached as Exh. C to Block Aff.); Second Amended Complaint, P 24.

On or about 23 September 1994, Quaker released its Annual Report to Shareholders for fiscal year ending 30 June 1994 (the "1994 Annual Report"). Second Amended Complaint, P 32. The 1994 Annual Report included the following statement: "At the end of fiscal 1994, our total debt-to-total capitalization ratio was 68.8 percent on a book-value basis, in line with out guideline in the upper 60 percent range. " 1994 Annual Report at 34 (emphasis added) (attached as Exh. E to Block Aff.); Second Amended Complaint, P 32. Plaintiffs allege the Leverage Ratio Guideline statement remained "alive" in the market uncorrected and unrevised throughout the Class Period. Second Amended Complaint, P 25.

Although all of Quaker's statements termed the Leverage Ratio a "guideline," Plaintiffs allege the 1993 Annual Report, including the Smithburg Letter to Shareholders, the September 1993 10-Q and the 1994 Annual Report established a leverage "ceiling" which the Board of Directors agreed not to exceed. Id., PP 6, 25. Plaintiffs further allege Quaker knew it was planning to exceed the Leverage Ratio Guideline by taking on additional debt to finance the acquisition of Snapple. Id., P 25.

2. Earnings Growth

On 4 August 1994, Quaker announced its financial results for both the fourth quarter of fiscal 1994 and for fiscal 1994. Id., P 26. Sales had increased to $ 1.618 billion, up from $ 1.545 billion, but due to major cost-reduction measures, net income dropped from $ 93.4 million to $ 23.5 million. Id., P 26. In connection with the announcement of its fiscal 1994 results, Quaker held a meeting for financial reporters and securities analysts. Id., P 27.

Plaintiffs allege Smithburg commented about the fiscal 1994 results and future strategies. Id. A Dow Jones News Wire report quoted Smithburg as stating, he was "'confident' of achieving at least 7% real earnings growth" in fiscal 1995 (the "Earnings Growth Target"). 4 August 1994 Dow Jones News Wire (attached as Exh. D to Block Aff.); Second Amended Complaint, P 27. The Earnings Growth Target was reiterated in the 1994 Annual Report which stated: "We are committed to achieving a real earnings growth of at least 7 percent over time." 1994 Annual Report at 33 (attached as Exh. E to Block Aff.); Second Amended Complaint, P 33. Plaintiffs, however, curiously exclude a significant portion of the Dow Jones News Wire report from the Second Amended Complaint. At the same meeting where Smithburg relayed his confidence in achieving at least seven percent real earnings growth in fiscal 1995, he also stated that Quaker had missed "its 7% target" in fiscal 1994. 4 August 1994 Dow Jones News Wire (attached as Exh. D. to Block Aff.).

Id. at 16-17. Therefore, on 20 January 1995, Plaintiffs filed the First Amended Complaint.
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On 13 March 1995, pursuant to Rule 12N, Appendix N of the General Rules Governing the United States District Court for the District of New Jersey, the Defendants filed a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.

On 25 April 1995, rather than dismiss the First Amended Complaint, Plaintiffs were permitted a second opportunity to amend and conform their allegations to Defendants' dismissal arguments. The original motion was denied without prejudice. Plaintiffs filed the Second Amended Complaint on 2 May 1995. Defendants refiled the Motion to Dismiss and completed supplemental briefing after enactment of the Private Securities Litigation Reform Act of 1995, Pub.L.No. 104-67, 109 Stat. 737 (22 Dec. 1995). Plaintiffs have not sought a third opportunity to amend.

Plaintiffs allege Defendants participated in the complained of acts and omissions in order to (1) artificially inflate and maintain the market price of Quaker common stock during the Class Period and thereby cause Plaintiffs to purchase the common stock at artificially inflated prices, (2) protect, perpetuate and enhance the executive positions and the substantial compensation, prestige and other perquisites of executive employment enjoyed by Smithburg and others and (3) discourage other companies from attempting to takeover Quaker by maintaining an artificially high market price for Quaker stock. Second Amended Complaint, P 11. Plaintiffs claim Defendants actions violate Sections 10(b) and 20(a) of the 1934 Act, 15 U.S.C. §§ 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5.

Defendants contend that Plaintiffs allegations, at most, attack the business judgment underlying the Snapple acquisition and fail to state a Federal securities claim. Defendants Brief at 2. Defendants argue they had no duty to disclose any facts regarding the acquisition prior to the November Press Release because there is no general duty under Federal securities law to disclose details concerning on-going merger discussions. Id. at 3. Defendants assert an affirmative duty to disclose on-going merger discussions exists in limited circumstances, but Plaintiffs failed to plead sufficient facts giving rise to such a duty. Id. Defendants further contend the public statements challenged by Plaintiffs were not rendered inaccurate or incomplete by non-disclosure of the Snapple acquisition discussions. Id.

Documents a court may consider include those specifically referred to in a complaint or other public records on which the claim is based, such as letter decisions of public agencies. Pension Benefit, 998 F.2d at 1197. If a court could not consider such documents, "a plaintiff with a legally deficient claim could survive a motion to dismiss simply by failing to attach a dispositive document upon which it relied." Dykes, 68 F.3d at 1567 n.3. Because Plaintiffs' claims are based, in part, on the 14D-1 and other publicly filed documents such as the 1993 and 1994 Annual Reports, they may be considered without converting the Motion to Dismiss into a summary judgment motion.

A court can refer to documents on which a complaint is based without converting a Rule 12(b)(6) motion into one for summary judgment because "reference to the full text is necessary to place the defendants' [actions] cited by plaintiffs in their complaint into the proper context." Renz v. Shreiber, 832 F. Supp. 766, 771 (D.N.J. 1993). This is consistent with Rule 12(b)(6) because "'when a complaint relies on a document the plaintiff obviously is on notice of the contents of the document and the need for a chance to refute evidence is greatly diminished.'" Dykes, 68 F.3d at 1567 n.3 (quoting Pension Benefit, 998 F.2d at 1196-97). In the Second Amended Complaint, Plaintiffs rely on various public documents including the 14D-1. See Second Amended Complaint, P 43(a). Consideration of the 14D-1 is appropriate because it puts Quaker's alleged conduct into a proper context. See, e.g., Renz, 832 F. Supp. at 771.

Omitted information is material if there is a "'substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.'" Basic, 485 U.S. at 231-32 (quoting TSC Indus., 426 U.S. at 449); accord Craftmatic, 890 F.2d at 639. When the impact of a corporate development is "contingent and speculative in nature"
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it may be "difficult to ascertain whether the 'reasonable investor' would have considered . . . omitted information significant at the time." Basic, 485 U.S. at 232.

While "'the task of determining whether a given omission is material is especially difficult when the plaintiff alleges nondisclosure of soft information . . . such as opinions, motives, intentions, or forward looking statements, such as projections, estimates and forecasts,'" a court can, as a matter of law, conclude an estimate of an action's cost to shareholders is not material for Section 10(b) and Rule 10b-5 purposes. Lewis, 949 F.2d at 652 (quoting Craftmatic, 890 F.2d at 642). Materiality is appropriately resolved as a matter of law when reasonable minds cannot differ as to the materiality or immateriality of the omissions. TSC Indus., 426 U.S. at 450; Craftmatic, 890 F.2d at 641.

The Leverage Ratio Guideline challenged by Plaintiffs stands in contrast to those cases where a defendant made statements which directly contradicted and were entirely inconsistent with the allegedly omitted material facts. For example, in Phillips, the Mesa Partnership ("Mesa") issued a press release stating that it was commencing a tender offer for 15 million shares of Phillips Petroleum Company ("Phillips") common stock. Id. at 1239. The press release also stated that Mesa would "not sell any Phillips shares owned by it back to Phillips except on an equal basis with all shareholders." Id. In the Schedule 13-D filed with the SEC, Mesa reiterated its intention to not sell shares back to Phillips except on an equal basis with all shareholders. Id. This statement was again reaffirmed by a Mesa spokesperson during a televised interview. Id. During subsequent negotiations between Mesa and Phillips, Mesa revised its Schedule 13-D eight times. Id. None of the amendments changed Mesa's original statement that it would not sell shares back to Phillips except on an equal basis with all shareholders. Id. at 1240.

Less than three weeks after Mesa's initial statement regarding its intention with respect to Phillips stock, Mesa and Phillips reached an agreement "in which all shareholders were not treated on an equal basis." Id. at 1241 (emphasis added). This was antithetical to the clear and absolute statement previously made. This Circuit held that Mesa's actions were reckless, satisfying the scienter requirement for a violation of Section 10(b) and Rule 10b-5. "A jury could . . . reasonably find making the statements to be an extreme departure from the standards of ordinary care." Id. at 1247.

Likewise, in Time Warner, the corporation announced a plan to forge "strategic alliances" to infuse itself with billions of dollars in capital in an effort to overcome over $ 10 billion in debt. 9 F.3d at 262. The corporation was also considering a new stock offering to reduce its debt; consideration of the stock offering, however, was not announced. Id. at 262.

The Second Circuit held that defendants' public statements regarding strategic alliances lacked the sort of definitive positive projections that would require later correction. Id. ("the statements suggest only the hope of [the] company that the talks would go well. No identified defendant stated that he thought deals would be struck by a certain date, or even that it was likely that deals would be struck at all"). Id.

The corporation's failure to disclose its consideration of a stock offering, however, was viewed differently. The court held Time Warner "may have come under a duty to disclose" because the stock offering would place the corporation's statements regarding strategic alliances in a different light. Id. at 268. The court was careful to limit its holding:

We hold that when a corporation is pursuing a specific goal and announces that goal as well as an intended approach for reaching it, it may come under an obligation to disclose other approaches to reaching the goal when those approaches are under active and serious consideration.

Id. (emphases added).

Quaker's comments regarding the Leverage Ratio Guideline are not analogous to the statements held actionable in Phillips or in Time Warner. Unlike the statements found to be misrepresentations in Phillips and Time Warner, Quaker never announced an express statement of intent; nor did it announce an "intended approach" for maintaining the Leverage Ratio Guideline in the upper sixty percent range.

Quaker's 1994 Annual Report states Quaker had recently acquired four companies and debt had increased significantly.
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1994 Annual Report at 35, 42 (attached as Exh. E to Block Aff.). A reasonable investor, therefore, was on notice that acquisitions and increasing debt were to be expected in the future. See id. No reasonable investor could interpret the Leverage Ratio Guideline as an absolute restriction on Quaker's ability to take advantage of a corporate opportunity which might cause Quaker to exceed the Leverage Ratio Guideline. If Quaker wanted to set an absolute ceiling rather than a guideline, it would have done so; it did not.
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The 1994 Annual Report expressly states that in the past "earnings per share increased 9 percent per year on average" in real terms for five consecutive years. 1994 Annual Report at 33 (attached as Exh. E to Block Aff.). This history of successful performance -- achieved during a period when Quaker was pursuing a strategy of using leverage to finance growth by acquisition -- fatally undermines any inference that Quaker's optimistic Earnings Growth Target lacked a reasonable basis when made. See, e.g., Kowal, 16 F.3d at 1279; Herskowitz, 857 F.2d at 184; Eisenberg, 766 F.2d at 776. Plaintiffs, therefore, have failed state a claim that the Earnings Growth Target lacked a reasonable basis when made or even once the Snapple acquisition was announced.
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Accordingly, the Second Amended Complaint fails to state a claim upon which relief can be granted. No allegation supports the contention that Quaker or Smithburg misrepresented a material fact or had a duty to disclose any aspect of the Snapple acquisition negotiations prior to the November Press Release. When no duty to disclose exists, there can be no finding of securities fraud. Plaintiffs' Section 10(b) and Rule 10b-5 claims are dismissed.

The claim that Quaker was obligated to disclose the Snapple acquisition benefitted management is, in effect, a claim that Quaker misrepresented the Leverage Ratio Guideline and Earnings Growth Target as part of its entrenchment scheme. Even if management motives in acquiring Snapple were self-serving as alleged, Quaker's "failure to disclose management's entrenchment scheme is not actionable under the Federal securities laws." Lewis, 949 F.2d at 651. "'Corporate officers and directors do not violate the Federal securities laws by failing to disclose an entrenchment motive or scheme underlying their actions.'" Id. (quoting Warner Communications, 581 F. Supp. at 1490). Indeed, "'the decision to resist a takeover is within the scope of directors' state law fiduciary duties, and there is no Federal securities law duty to disclose one's motives in undertaking such resistance.'" Id. at 652 (quoting Panter v. Marshall Field & Co., 646 F.2d 271, 290 (7th Cir.), cert. denied, 454 U.S. 1092, 70 L. Ed. 2d 631, 102 S. Ct. 658 (1981)).

G. Controlling Person Liability

Plaintiffs contend that, in addition to his liability for primary violations under Section 10(b) of the 1934 Act, Smithburg is also secondarily liable as a controlling person of Quaker under Section 20 of the 1934 Act, 15 U.S.C. § 78t(a).
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To establish controlling person liability against Smithburg there must first be primary liability on the part of Quaker.

"Once all predicate § 10(b) claims are dismissed, there are no allegations upon which § 20(a) liability can be based." Shapiro, 964 F.2d at 279; VT Investors v. R&D Funding Corp., 733 F. Supp. 823, 841 (D.N.J. 1990) (controlling person claims must be dismissed as a matter of law when the underlying core allegations are dismissed). Accordingly, because the Section 10(b) and Rule 10b-5 claims are dismissed, the controlling person claim under Section 20 is also dismissed.

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